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• Net Income
• Paycheck
• After-tax income
Marginal Propensity to Consume
(MPC)
• The fraction of any change in
disposable income that is consumed.
• MPS = ΔS/ΔDI
Marginal Propensities
• MPC + MPS = 1
– .: MPC = 1 – MPS
– .: MPS = 1 – MPC
• Remember, people do two things
with their disposable income,
consume it or save it!
The Spending Multiplier Effect
• Why does this happen?
–Expenditures and income flow
continuously which sets off a
spending increase in the economy.
–Read pg. 199
The Spending Multiplier Effect
– Ex. If the government increases
defense spending by $1 Billion,
then defense contractors will hire
and pay more workers, which
will increase aggregate spending
by more than the original $1
Billion.
Calculating the Spending Multiplier
• The Spending Multiplier can be
calculated from the MPC or the MPS.
• Multiplier = 1/1-MPC or 1/MPS
20 5 100 increase
_____ X ______ = ______
16 X ______
_____ 5 80 increase which is less than
= ______
The increase of 100 from G.
What would be the effect on the economy (GDP) of a
decrease of $100 billion in G. Assume the MPS =.25
AE x M = GDP
10 4
______ X ______ = 40 Billion
Key Formula: AE x M = GDP
M = 1/MPS or 1/1-MPC or GDP/ AE
• If the economy is in a recession and has a GDP
gap of $50 billion, how much must government
increase G to close the GDP gap and return to
full employment, assuming an MPS of .20?
5
M = 1/MPS = 1/.20 = _____
AE x M = GDP
______
10 X ______
5 = 50 Billion
If $500 billion in AE $1000 billion
in GDP, then how much would G have
to to reach a YF of $2000 billion?
• $2000B
• $1000B Explanation:
• 1000/500 = 2 = Multiplier =
$500B
GDP/AE
• $200B AE x Multiplier = GDP
G x 2 = 2000
• $100B G = 1000
The value of the spending multiplier
decreases when?